Greetings, and welcome to the Proto Labs Second Quarter 2020 Earnings Call. At this time all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded.

It is now my pleasure to introduce your host, Daniel Schumacher, Director of Investor Relations. Thank you, you may begin..

Thank you, Michelle, and good morning, everyone. With me today is Vicki Holt, our President and Chief Executive Officer; and John Way, our Chief Financial Officer. This morning, before the market opened, Proto Labs issued a press release announcing its financial results for the second quarter ended June 30, 2020.

The release is available on the company's website at protolabs.com. In addition, a prepared slide presentation is available online at the web address provided in our press release.

Before we begin, I would like to remind everyone that our discussion will include statements relating to future performance and expectations that are or may be considered forward-looking statements and subject to many risks and uncertainties that could cause actual results to differ materially from expectations.

Please refer to our earnings press release and recent SEC filings, including our annual report on Form 10-K, for information on certain risks that could cause actual outcomes to differ materially and adversely, from any forward-looking statements made today.

The results and guidance we will discuss include non-GAAP financial measures consistent with our past practice. Please refer to our press release and the accompanying slide presentation within the Investor Relations section of our company website for a complete reconciliation of non-GAAP to GAAP results.

Now, I'd like to turn the call over to Vicki Holt, President and Chief Executive Officer of Proto Labs.

Vicki?.

Thanks, Dan. Good morning, everyone, and welcome to our second quarter 2020 earnings conference call. Thank you for joining us today. I would like to start by expressing how proud I am of this Proto Labs team, and how we've handled the first-half of 2020. Like all businesses, we've had to evolve considerably in the first six months of the year.

Proto Labs has rapidly adapted to change guided by our core values of teamwork, trust and achievement. As I mentioned on our first quarter call, our top priority is to keep our employees, communities and customers safe.

Our manufacturing and office teams worldwide have done an incredible job of ensuring employee safety, while continuing to delight customers with our industry leading digital manufacturing services. Every one of our manufacturing facilities have remained operational throughout the global pandemic.

The safety of our employees is extremely important to me, and our essential manufacturing employees are my heroes. I would like to thank them all for what they do to make Proto Labs a great organization.

We have had some confirmed cases of COVID-19, but we believe they occurred outside of our facilities, and we have been able to greatly limit the impact to other employees. Our new cleaning and sanitizing standard operating procedures in all our manufacturing facilities have continued since the beginning of the COVID-19 pandemic.

In addition to new procedures that minimize employee interaction, our digital manufacturing model offers an advantage in practicing social distancing, compared to more manual traditional manufacturing operations.

Upon entry into our manufacturing or office facilities, we are conducting rapid temperature screenings via infrared camera technology, and have put in place a mandatory mask policy in all of our facilities. We are following local guidelines in each of our locations, and the vast majority of our office employees continue to work remotely.

While I'm not surprised, I am very impressed with the agility and creativity with which our employees have adapted to the changes thus far in 2020. A crisis like the COVID-19 pandemic provides an opportunity for Proto Labs to demonstrate the value our digital business model can provide.

Our purpose is to accelerate innovation from development through commercialization, and we've been able to deliver on that purpose during this crisis. The way we interact with customers has not changed, as we are an e-commerce technology enabled company.

Through the second quarter, we continued to prioritize orders to equip the medical system to treat patients with COVID-19, and provide customers with additional consultative design assistance, to get parts designed and manufactured rapidly.

Our digital manufacturing model allows us to help our customers rapidly produce parts to respond to COVID-19, including testing, preventing the spread, or caring for patients that have contracted the virus.

To-date, we've manufactured and shipped over 8 million parts to be incorporated into products responding to COVID-19, at many different medical-related customers, resulting in $12 million of revenue recognized in the second quarter. We are grateful and proud to continue to serve our customers and contribute to the fight against this novel virus.

Now turning to our financial results in the quarter, today, we reported second quarter revenue of $107 million, representing a decline of 8.1% over the second quarter of 2019, and a 7.4% sequential decrease.

Our revenue decline is a result of the broad challenges impacting our customer base, and also include the $12 million of COVID-19-related revenue. On a monthly basis, our second quarter revenue trend played out as follows. As we noted in our Q1 call, April revenue was down approximately 4% year-over-year.

Global industrial manufacturing activity was severely impacted by COVID-19 and stay-at-home orders in April. Our business was aided by $5 million in revenue from COVID-19-related orders in April. May was the softest month in the quarter, with activity picking up slightly in June.

The COVID-related business continued through May, and helped to mitigate the softness we experienced in the rest of the business during the month.

To gain additional insights in this uncertain market, we conducted a survey of over 500 customers across a variety of industries in order to learn how customers and supply chains have been impacted by COVID-19. 73% of respondents indicated they are working remotely, 43% have experienced a decrease in demand for their products.

Regarding timing and development schedules, 58% of our customers surveyed have seen delayed development project timing, and 33% have seen reductions in project funding. These changes are reflected in our revenue performance and the number of unique product developers served in the second quarter of 2020.

I will now transition to second quarter 2020 revenue by geography, highlighted on Slide 5 of our earnings presentation. Americas revenue declined 5% compared to the second quarter of 2019. Revenue declined significantly in our industrial and consumer end markets in the Americas.

Our aerospace customer end market continued its strong performance in 2020, during the second quarter. Automotive also increased year-over-year. Europe’s second quarter revenue declined 20% year-over-year, or 18% in constant currency. Demand was off in all European customer end use markets. In Japan, revenue declined 21% or 23% in constant currency.

Overall, our business declined 8% year-over-year in constant currency during the second quarter of 2020. Revenue by service for the second quarter is presented on Slide 6 of our earnings presentation. Injection molding revenue grew 4% compared to the same period in 2019, due to strong demand for COVID-19-related components.

Excluding COVID-19 revenue, year-over-year injection molding revenue declined 17%. 3D printing, CNC Machining and Sheet Metal were all down year-over-year, as muted demand was not offset by demand for COVID-19 revenue in those services. Turning to earnings, we reported second quarter non-GAAP EPS of $0.59 per, down only $0.02 sequentially.

Our earnings in the second quarter were down, primarily due to lower volume and fixed costs absorption, partially offset by lower variable compensation and discretionary spending.

We continue to manage expenses as demand remains soft, including labor and variable manufacturing costs, leadership and board compensation reductions and tightly controlling discretionary spend. John, will dive deeper into our financial performance during the quarter, a little later on the call.

Despite the challenging economic environment, we are still focused on investing in and executing on key strategic initiatives to position our business for strong growth in the future. Our Protolabs 2.0 systems project is the prime example of this commitment.

To maintain our position as the leader in digital manufacturing, we continue to push ahead on work-related to Protolabs 2.0, including development, documentation, validation, training, and testing.

As a reminder, Protolabs 2.0 is a systems project we've undertaken to enhance and evolve our systems and processes, to support our customers and our strategy for the next decade and beyond. There are two main components of Protolabs 2.0.

One, to enhance our e-commerce platform and customer experience, and two, to improve the functionality and interconnectivity of the backend systems, which support our operations. Protolabs 2.0 will allow us to come out of this pandemic stronger than we entered.

We continue to operate under a plan to go live with the new systems in Europe, by the end of 2020, followed by the Americas in 2021. We’ve recognize that there is both external and internal risk to that plan.

Externally, travel restrictions and social distancing due to COVID-19 pandemic, could present challenges and delays in assisting our operators in Europe with work necessary to go live. Internally, as we continue to test our new systems and prepare for the go live event, unforeseen issues could arise and push back our intended go live date.

Our focus is on ensuring that the customer experience is favorable in the new system. Although we've been conducting user acceptance testing for months, we are happy to report that we completed our first round of live customer beta testing in early July, with 212 customer participants from 15 countries across Europe.

Feedback on the customer facing component of Protolabs 2.0 was extremely positive. Beta participants described the new customer experience as streamlined, intuitive, modern, and easier to use in our current system. As expected, the first beta test of any new software system, or a recent tests also uncovered areas that need attention prior to launch.

Our teams are working diligently to address these areas, complete development, validate and test our systems as we approach our plan go live date.

We will continue to focus on user testing in the U.S., as well as testing the system, the business processes, and our employees training to ensure we're ready to serve our customers with the rapid and reliable service they expect from Proto Labs.

I am so proud of our teams and their work on Protolabs 2.0 to-date, the level of teamwork across all functions and regions, all while transitioning to remote working environment is extremely impressive. Our teams are working hard every day to make Proto Labs a stronger, more successful company, with highly differentiated leading-edge technology.

In summary, the first-half of 2020 has presented a great deal of challenges to all businesses and Proto Labs is no exception. We have a solid financial foundation and a healthy balance sheet to weather the uncertain environment. In addition, the team has demonstrated the resiliency of our dynamic digital manufacturing business model.

We will continue to flex costs where we can to match demand, but we will not sacrifice the long-term growth of the company. Our agile and creative employees will be there to help our customers succeed, as they begin to come back to work and reaccelerate development projects to meet the needs of their customers, as momentum build in the recovery.

With that, I'd like to turn the call over to John for an in-depth look at our financial performance in the second quarter, as well as our outlook for the third quarter..

Thank you, Vicki. Second quarter financial results begin on Page 8 of our presentation. Revenue in the second quarter was $106.6 million, a decrease of $9.4 million over the same quarter in 2019. Foreign currency representing the $350,000 headwind in the quarter, resulting in revenue decline of 7.8% in constant currency.

We served 17,000 unique product developers in the second quarter. As a reminder, our unique product developers served metric enumerates individual product developers that purchased parts from us during the corresponding quarter.

Consistent with our results of our customer survey, many of our customers have been impacted by COVID-19, stay-at-home orders and business shutdowns.

The 18.2% decline in product developers served was greater than our year-over-year revenue decline, due to the relatively large order size of the COVID-related orders, with $12 million in revenue coming from relatively few individuals.

Turning to Slide 10, to review the income statement, our non-GAAP costs of revenue decreased $3 million compared to the first quarter, resulting in gross margin of 50.1%. This reduction was a result of very focused efforts of our plant managers to align staffing to the significant variability from week-to-week across our manufacturing services.

The reduction in cost of revenue did not correspond to the revenue decline, due to the challenges in adjusting our fixed cost structure, resulting in 110 basis points sequential decline in gross margin.

Continuing with the operating expenses, non-GAAP operating expenses totaled $34.6 million in the second quarter, down $3.7 million sequentially, reflecting our focus on controlling variable and discretionary costs.

We have eliminated essentially all of our discretionary spend, and are prudently managing costs given the uncertainty with respect to the demand for our services. Aside from these spending reductions, lower incentive compensation expense, lower tradeshow activity, and travel were the largest drivers of lower operating expenses.

Non-GAAP operating expenses as a percent of revenue in the most recent quarter was 32.5%, down from 33.3% in the first quarter of 2020. Non-GAAP sales and marketing was 15.2% of revenue, down from 16.1% in the second quarter of 2019, and 15.3% in the prior quarter.

Sequentially, the $1.4 million decline in sales and marketing expense was driven by lower variable compensation, travel expense and a reduction in tradeshow activity. Research and development expense on a non-GAAP basis in the second quarter was $8 million, down from $8.5 million in Q1, primarily due to lower incentive compensation.

Our R&D expense did increase compared to the prior year, as we continue to invest in Protolabs 2.0, a key priority to drive future business performance. Non-GAAP general and administrative expenses were $10.4 million in the quarter, down $1.9 million compared to Q1.

As a reminder, first quarter G&A included an additional allowance for doubtful accounts of approximately $1 million, accounting for a portion of the reduction. The remaining sequential decline was driven by lower incentive compensation accruals, executive pay reductions and lower travel and entertainment.

GAAP operating income was $14.4 million or 13.5% of revenue in the second quarter. Adjusted non-GAAP operating income was $18.7 million or 17.6% of revenue. On a GAAP basis, our tax rate was 16.6%, down from 21.9% in the second quarter of 2019.

The year-over-year decline in our GAAP tax rate was primarily due to an increase in the research and development tax credit, as well as an increase in tax benefits associated with equity compensation.

On a non-GAAP basis, tax rate was 18.1% in the second quarter, compared to 22.7% in the same period in 2019, principally due to the higher R&D tax credit. On a GAAP reporting basis, net income totaled $12.6 million, resulting in diluted earnings per share of $0.47 per share.

Adjusting for the after-tax cost of stock compensation, amortization of intangibles and unrealized foreign currency gains. Our non-GAAP diluted earnings per share in the quarter was $0.59, representing a $0.12 per share decrease from the prior year, and a sequential decrease of $0.02 per share.

Breaking down the sequential earnings per share change further, lower volume resulted in a $0.05 per share reduction. This reduction was partially offset by a $0.03 per share benefit resulting from the lower effective tax rate. Now turning to cash flow on Slide 11, we generated $31 million in cash from operations during the quarter.

Even when our revenue growth is not at historical levels, our business continues to produce very strong cash flows due to the digital nature of our quoting and manufacturing platforms.

Capital spend in the second quarter was $19.9 million, including investments in Protolabs 2.0, investments in facilities in Europe and equipment, primarily X1 3D printer to expand our 3D printing capabilities.

Given our strong cash generation and balance sheet, we continued our opportunistic stock buyback strategy under a 10b5-1 plan during the second quarter. We're returning capital to shareholders by repurchasing 38,000 shares of our common stock, at an average price of $70.81, resulting in total purchase price of $2.7 million.

We have $35 million remaining under our buyback program. We ended the second quarter with the cash and marketable securities balance of $175 million, up from $167 million at the end of the first quarter. In addition to our strong cash position, our balance sheet remains it's free of debt.

Now turning to third quarter guidance, on our last earnings call in late April, we did not provide formal revenue and earnings per share guidance for the second quarter, because of the vast global economic uncertainty.

Although, the global pandemic is still active and macroeconomic conditions remain unpredictable, we believe it's prudent to provide formal third quarter revenue guidance, based on what we're seeing in the start of the third quarter and our historical experience to provide additional transparency to shareholders.

Our third quarter 2020 guidance has summarized on Slide 16. We currently expect third quarter revenue to be in the range of $98 million to $110 million, compared to $106.6 million in the second quarter. The second quarter included $12 million of COVID-19-related orders, and we believe are non-recurring.

This results in a revenue base line of $95 million as we entered the third quarter. As we progressed through the second quarter, May revenue was the trough, and we saw a slight improvement in June. July revenue trends have remained fairly consistent with June, and we estimate July revenue will be down approximately 11% compared to July 2019.

We’ve increased a range of our revenue guidance, given the ongoing uncertainty related to COVID-19 and the impact that stay-at-home orders have had on our unique product developer accounts.

Given the broader range in our revenue guidance and the magnitude of impact on earnings per share at either end of the range, we believe it is more meaningful to provide a qualitative information related to the expenses of our business. We will continue to manage our cost structure in response to the revenue levels in each of our services.

We expect our non-GAAP third quarter gross margin to be between 49% and 51%. We expect to manage our non-GAAP operating costs, generally in line with or below second quarter levels. Our non-GAAP add backs for the quarter will include stock compensation costs of approximately $3.6 million and amortization of approximately $725,000.

We currently estimate our non-GAAP tax rate to be approximately 21% to 22% in the third quarter, up from 18.1% in Q2, resulting in a $0.03 per share headwind. One further reminder, as it pertains to guidance beyond Q3.

Upon placing Protolabs 2.0 into the service, we will begin amortizing the system, which will result in approximately $1.5 million of expense per quarter. In addition, we estimate that we will incur an additional $1.5 million to $2 million in expenses each quarter for a couple of quarters, related to contractors and other go live related costs.

I will now turn the call over to Vicki, for some final comments..

we're establishing a diversity and inclusion task force made up of passionate employees across the company, we will focus on three areas, employee education, HR practices around recruitment, development and career advancement, and collaborations on partnerships in our communities to promote diversity and equality.

Proto Labs is committing to take action to make sustainable change for our employees and our communities. Going forward, we will continue to provide customers, the world class, digital manufacturing services they have come to expect from Proto Labs, while maintaining the health and safety of our employees, communities and customers.

As an e-commerce digital on-demand manufacturer, we are very well-positioned to help our customers, navigate challenges they currently face and future changes in their business. We will continue to respond and adjust our cost structure where we can to manage our business performance in the short-term.

But we will continue to drive the business ahead and ensure our position, as the digital manufacturing leader continues long into the future. This concludes our formal remarks. Now, John and I would be happy to take your questions. Michelle, can you please open up the line for Q&A..

[Operator Instructions] Our first question comes from the line of Brian Drab with William Blair. Please proceed with your question..

Hi, good morning. Thanks for taking my questions..

Good morning, Brian..

Good morning, Brian..

So, you mentioned very clearly that May was the softest month.

Can you just talk through what the customer activity has looked like as we've moved through the months here and into July as -- have June and July, have you seen continued improvement in those months?.

So, May was the trough tropic. It picked up some in June and July has stayed pretty consistent with June activity. I think, I mentioned in my comments that we're looking still as an estimate for July, as we finish out the week, but somewhere in that 11% range down 10% to 12%, something like that..

Okay, thanks.

And then how have -- looking at the different service lines and how have the different service lines been trending? And maybe you could comment on why it looks like injection molding is holding up quite a bit better than CNC in this environment, even if you exclude or actually specifically if you exclude the COVID-related order?.

Yes, injection molding as you know is our most differentiated service. And in this time of the supply chain disruptions and need for speed in areas like COVID-19, we really provide significant customer value. So, I think that's probably a good reason why it's holding up a little bit better.

Again, it's up when you include COVID, if you exclude COVID, injection molding is down 17%. So, it's still significantly impacted by the economic situation that we're dealing with..

Okay, understood. And I'll just ask one more for now. I guess, can you talk about what you're expecting for gross margin? I think you mentioned, I've got a couple of conference calls going simultaneously here.

But what's the expectation for gross margin for the balance of the year? And where do you see that in an environment where things have become a little bit more normal? What do you think you can do with gross margin '21? And then also how does Protolabs 2.0 play into that and potentially help gross margin?.

Yes. So, a lot in that question. I think as we've talked about volume significantly impacts our gross margin, and our ability to flex. With higher volumes, we can drive improvement in the gross margin.

I think for the third quarter, we provided guidance in the range of 49% to 51%, which is essentially bookends where we finished here in the second quarter. Again, volume is going to be a big driver of where that goes in the fourth quarter and into 2021. And I think, we'll just have to continue to watch where that plays out.

But, as we return to growth, that's when we'll see improvements in the gross margin over the long-term..

John, have you said on the call yet where or how big an impact Alphaform and Rapid each had on gross margin? Can you give us those numbers again if you haven't?.

Yes. So, New Hampshire is about 230 basis points of an impact on the quarter. And then 3D printing in Europe was about 130 basis points..

And where are those gross margins, the absolute gross margins now on those businesses roughly?.

They are currently sitting -- the Europe 3D is just below 10% and Rapid business is in the mid-20s..

Okay. Thanks very much..

Thank you. Our next question comes from the line of Greg Palm with Craig-Hallum Capital Group. Please proceed with your question..

Yes, thanks. I guess just starting off since you didn’t provide guidance last quarter.

I am curious how did the quarter compared to your own internal expectations? And I guess outside of healthcare in the COVID-related revenue any end markets that surprised significantly either to the upside or downside?.

Yes. It played out as we expected it to when we gave the guidance. We gave a lot of color as you recall around April. I think the May was a little softer than what we thought, but it’s rebounded little bit in June. In terms of end markets, not a lot different, aerospace has been very strong for us.

As you know, we play not in the commercial aircraft part of aerospace, but more in satellite, communications space side of aerospace, and that’s been really strong for us all year. Other maybe little bit of surprise, auto was up slightly here in North America, that might be a surprise, but not significant.

So, yes, I don't think anything else really surprised us. I think Europe has been very slow to recover. You think with some of the opening up happening in Europe, we see some faster recovery there. Some of our speculation is a lot of the economies in Europe are very export oriented in the manufacturing space.

And again, we play in the industrial manufacturing space. So, with the weaker export economies that could be impacting Europe, even though, they're opening up a little bit..

Yes. Greg, I think, maybe as I look back, remember our call was at the end of April. We had a lot of uncertainty at that point in time. I think as we continue to progress through the quarter, it ended up maybe a little bit better than where we were or where we were expecting, but we had a pretty wide range, just because we didn’t really know.

I think one area that we did outperform was and I mentioned in the call, the ability for our plant managers to really dial-in and match that cost structure to what the revenue was coming in for the next week, really helped our gross margin in these uncertain times.

And as you think about it across the individual plants, our injection molding plants were really busy because of the COVID orders. So, they were trying to flex up, while a lot of our other plants were trying to flex down and our plant managers just did a great job of managing those costs..

Yes. Okay. It makes sense. I guess, as it relates more to the cost structure, I mean, it seems like there are a number of trends coming out of this pandemic that could really accelerate growth and adoption of your services. I mean, I'm thinking, reshoring on demand digital, I mean, sort of the list goes on.

And I guess I would have thought you may have started to ramp up spending here, whether that's Q3 or second-half, whether that's sales or marketing, just try to take advantage of everything going on, but it seems like you are keeping it really, really tight lid in the near-term.

So, how do I reconcile that to your comments, Vicki about not sacrificing long-term growth, potential? I don't know maybe it's just more discretionary spending, but it seems like we're in an environment where you'd want to take advantage of it sort of a land grab opportunity here?.

Yes. We are doing quite a bit of shifting to make sure that we are taking advantage of the situation. So, particularly in marketing, we've been shifting to a much more digital appearance in marketing and also taking advantage of our leadership to thought leadership in the area of supply chain disruption as well as e-commerce.

So we've had some great opportunities to showcase the company across a number of different venues, but in a very digital way. And that's one of the advantages that we have. We can pivot digitally very easily since we are such a digital company.

And those are some lower cost approaches to marketing, as compared to trade shows, which can be quite expensive. So, I think we'd pivot and are investing appropriately in growth. We want to make sure that, we are managing our costs in this uncertain environment.

And not being -- I don’t want to say, frivolous in the spend at a point in time, when many of our customers, as I mentioned in the survey results that we got are really working remotely and their projects have been delayed or often reduced funding. So, let's spend where it makes sense in order to get the revenue growth..

Okay.

And John, just to be clear, as it relates to Protolabs 2.0, can you just repeat what you said about -- just the additional amortization and expense, does that occur when Europe goes live? Or is that half of that when Europe goes live, and half as the Americas? Maybe you can just go with that one more time please?.

Yes. Actually, when we place the asset into service, we will start amortizing it, because it's one system built for the entire company. So, once we place it into service and the monthly expense will be roughly $500,000 a month.

And then, because of that, when we place in service, we still will have some of that contractors, that costs flips from capitalized expense or capitalized costs to expense, as we continue to go live and work through that process..

And you said Q4 was go live, correct?.

Yes. I'm sorry. That's our current plan..

That's our current plan..

Thank you. Our next question comes from the line of Jim Ricchiuti with Needham and Company. Please proceed with your question..

Hi team. Mike Cikos here on the line for Jim Ricchiuti. Just a couple of quick questions here. The first, I wanted to make sure that I understood correctly, but the COVID-19-related revenue, the $12 million that you guys had called out, that is entirely flowing into that injection molding service line. And then the second item -- sorry, go ahead..

No, it's not entirely in injection molding, but the vast majority of it is. I think like 90% plus is on the injection molding..

Yes, it's about. Yes..

Okay. And I guess coming back to the OpEx discipline that you guys were able to show.

Curious, could you help parse out how much of that is tied to the incentive comp versus discretionary spending? And then if I'm thinking about the guidance and commentary, if we're looking to Q3, where is the additional benefit or costs control coming from if we're thinking about OpEx being either stable to down sequentially?.

Yes. So, the incentive comp was about $1.5 million or so of that cost reduction. I think as we look to Q3, we’ve flat to down in the operating expenses. I think it's just continuing to look at the areas of where we're spending in, and looking at opportunities related to that. So again, the COVID kind of hit us in March, and we were developing plans.

So, the cost reductions, as we've been managing costs, we've been kind of picking up momentum, as we've gone through the year. So that momentum, I think, will carry on through the end of the second quarter into the third quarter. So I think a good chunk of it'll be run rate.

And I think we had some expenses in Q2, even related to safety of our employees, making sure that we've got masks and protective equipment and things like that, that flows through that. And we've got most of that stuff on hand now, and we'll be incurring some of that expense..

Okay. And if I'm thinking about the recovery that you guys are seeing now, in June similar activity in July versus where we were in May being the trough.

Just curious, what are the some of the end markets, the service lines where you're seeing some of the, I guess better improvement versus some of the markets that are tending to lag right now?.

So, when we say improvement, so June was a little bit better than the trough in May, and July is pretty consistent with June, maybe a tad better. So, we continue to see strength in our aerospace segment.

But the rest of the segments are pretty evenly split in terms of where recovery comes, maybe a little bit better with computer electronics than we're seeing in general from automotive. So it's still pretty broad brushed, manufacturing industrial segments remain weak. So, industrial machinery and equipment remained pretty weak.

So, it's very gradual, it's not a Z [ph] by any stretch of the imagination..

Okay. Understood. And then just final housekeeping guiding here. I know you guys were talking about that. Call it $1.5 million a quarter in amortization, once Protolabs 2.0 goes live. And then there was also the contractor cost and other go live costs of about $1.5 million to $2 million a quarter. Just wanted to make sure I understood that correctly.

So, the contractor and go live costs for $1.5 million to $2 million, how should we be thinking about it? Is that going to be multiple quarters that's going out?.

I think, think about two quarters is how we're currently planning that. And that is a little bit of uncertainty around that, but I would think of that as a onetime cost for a couple of quarters after we go live, whereas the amortization obviously will be recurring..

And those will obviously turn on alongside the amortization, and so we should expect I guess with those in aggregate for those first two quarters then?.

Yes. Unfortunately, that's the way it'll work right. Some of those contractors that are here helping us develop that system. When we go live, we cease capitalization, so that cost turns from a capitalized item to an expense at the same time when we start amortizing the system..

Sure. Alright. I appreciate the color guys. Thank you very much..

Thank you. Our next question comes from the line of Andrew DeGasperi with Berenberg. Please proceed with your question..

Good morning. Just a few questions from me as well. First, just a quick one, a follow-up to Mike. You mentioned the commercial aerospace was strong.

I mean, can you give us maybe an idea of how did it skew like the defense versus commercial aerospace?.

I'm sorry..

Defense versus commercial..

Yes. So, it is definitely more on the defense side as well as what I would call space and telecommunications side of aerospace. We are not really big on the commercial aircraft side..

Got it. And just maybe some high-level question in terms of -- I think you mentioned in the prepared remarks that a 58% of your customers have delayed project timing in terms of the development cycle.

Can you maybe let us know if this has to do with some of the physical testing labs being shut during the last few months, or a shift to, call it, more virtualized prototyping? Anything on that would be helpful..

Yes, I think that’s a combination of both. So, we do a lot with the large industrial testing labs and many of those were shut down for a good part of -- early part of second quarter, starting to get some reopening of some laps on limited basis.

But that's why we did that survey, really wanted to understand what was happening with our customers, in particular our product developers, and how are they being able to do their job during this period of time. And it's difficult, again, we said 73% of them are working remotely.

And they've seen a decrease in demand for the products that they support. And their development cycles have been pushed out or seeing reduced funding, 33% have seen reduced funding. So, it helps us understand a little bit about what's happening with our product developers served, they're just out there with fewer projects today.

And that's what we're seeing reflected in the underlying weakness in our revenue.

As they begin to come back to work, which they will, and as they begin to drive innovation, which manufacturers will do in order to recover on the other end of this economic shock that we're seeing, we will see them get back to work and we will see them again placing orders again.

But we're dealing with a structural change and how they're working right now..

That's helpful.

One more for me is, in terms of on competition, cam you maybe update us how are your legacy competitors, like the machining place is doing today? And then maybe also, can you let us know if there are any emerging competitors from a service bureau perspective?.

Yes. So, I really don't know, how they're doing to be honest with you. I would think that they're seeing especially on the CNC machine, the same kind of reduction in demand that we're seeing, which given some of their financial structures might be more difficult for them. We do quite a bit of secret shopper.

We're following what's happening with pricing in those end markets. We've seen some softening in some of that pricing, as some of those smaller mom-and-pops who are working more on just making sure they're covering their cash needs, might be picking up some business at price points that are lower than they might've historically picked up.

So, we respond to those as we hear them, and induce so prudently, but we are seeing some competition there. Haven't seen any new service bureaus emerge, and the only other kind of emerging competitors are the ones we've spoken about before, which are more of the broker kind of model with e-commerce..

Got it. Thank you very much..

Thanks..

Thank you. Our next question comes from the line of Ben Rose with Battle Road Research. Please proceed with your question..

Yes. Good morning, Vicki and John. Few questions for me. Firstly, on the medical, in the medical device area.

Could you speak to, how the business is performing ex-COVID-19? I know that this is your largest vertical, but maybe just some trends or color on the performance of that segment?.

Yes. So, if you take a medical segment and you pull the COVID business out, it actually declined by 14%..

Okay.

Any general commentary there? Is it just kind of across the board or in certain?.

It is basically across the board. I mean, a lot of the product developers served, that we survey in our -- in the survey that I mentioned, many of them are in the med device space. And they're working from home and some of their projects have been either diverted or slowed down in this environment..

Yes. And if you think about those businesses, any of the elective procedures aren’t happening right now. So, a lot of those segments that we're doing business with, their business is hurting quite a bit. So, they're trying to figure out the path forward and they're managing their costs pretty tightly right now as well..

Okay. And with regard to your current capacity, both in the U.S. and Europe, perhaps John, you could speak to the level of capacity that you're operating at now.

And then either for John or Vicki, is there a formal policy in place with regard to furloughs or addressing specific workers that may not be needed for the complete time over the next quarter or two?.

Yes. So, I think from a capacity standpoint, we’ve got capacity in each of our facilities. And I think if you just go back to some of the historical trends of the revenue we had produced historically, I haven't done the actual calculations because the times when we look at it, as is when we're looking to add the machining capacity.

As far as the labor, I think I will reiterate, like the team has done a great job of flexing that labor. We are built for a certain amount of variability, so we have a flexible staffing model that we can flex up and down. Unfortunately, in some of our plants, we have had to do some furloughs and take some actions like that.

But, we're managing those costs to correspond with the volumes that are coming in, and are looking to drive the growth so we can bring those employees back..

And we’re taking advantage of government programs in each of the areas in which we work. Germany has got a shared work program. UK has got a furlough program. And in a couple of the States that we have had to take furloughs here in the United States, they have shared work programs as well.

So, really working to try to minimize the impact of our employees. We continue to cover healthcare benefits and they remain on our headcount and hope to bring them back as soon as we can, when we see the recovery occur..

That sounds good. And then finally, at least for now. I am intrigued by the customer survey that you took. It sounds like a great idea to get a handle on customer thinking at this point for sure.

I was curious, were there any questions in the survey that addressed customer expectations heading into the fall, whether they might see a return to normal or a pickup in project activity?.

Yes. We did not ask that. We were really just focused on what is it that they were doing at this period of time. I'll just say, as we talk to customers, they share the same level of uncertainty that we do. So, our customers are very hesitant also to predict kind of what the next few months are going to look like.

I think we're all being very responsive, being very agile and adaptive..

Okay. Thank you very much..

Thank you. We have reached the end of our question-and-answer session. I'd like to turn the call back over to Mrs. Holt, for any closing remarks..

Thank you. I would like to thank Proto Labs employees for their efforts in the first-half of 2020, and through these extremely uncertain times. I also want to thank our customers for their continued support. We are committed to pushing this company forward through the challenges and changes.

We will continue to improve our offering, our company culture and our financial performance. In the near-term, we will continue to adapt and grow as an organization and over the long-term we're committed to driving great shareholder value. We look forward to reporting to you on our progress during our next call. Thank you..

Thank you. This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation and have a wonderful day..